Audits, Investigations and Sequestration! Oh My! - Venable LLP

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Audits, Investigations andSequestration! Oh My!

- A presentation about challenges government contractors are facing withDCMA, DCAA, internal investigations and preparing for sequestration. -

John F. Cooney, Partner, Venable LLPPaul A. Debolt, Partner, Venable LLP

John M. Farenish, Partner, Venable LLPScott Hommer, Partner, Venable LLP

Donald J. Shoff, CFO, INDUS CorporationJim Winner, V.P. & General Counsel, ITT Exelis

March 13, 2012 Tysons Corner

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© 2012 Venable LLP

Biographies

Scott Hommer, Partner at Venable LLP, concentrates his practicein business counseling and litigation with an emphasis ontechnology companies and government contractors. Herepresents clients locally, nationally, and internationally on issuesincluding negotiating contracts, acquisitions, protecting intellectualproperty rights, and successful litigation. Mr. Hommer also hassignificant experience in counseling clients who do business withthe federal, state, and local governments and has representedclients on contract administration matters, contract claims anddisputes, bid protests, contract terminations, teamingagreements, conflict of interest issues, intellectual property rightsissues, government socio-economic programs, and smallbusiness matters.

[email protected] 703.760.1658

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Biographies

John F. Cooney, Partner at Venable LLP, focuses oneconomic regulatory, administrative, and constitutionallitigation involving federal agencies at the trial and appellatelevels. His areas of experience include financial services,white collar defense, environment, and separation of powers.Mr. Cooney has 35 years of experience in regulatory policymaking and regulatory litigation. He served as Assistant to theSolicitor General, Department of Justice, and as DeputyGeneral Counsel for Litigation and Regulatory Affairs, Officeof Management and Budget. Mr. Cooney served as counselfor OMB’s Office of Information and Regulatory Affairs, whichreviews agency regulations on behalf of the President, andwas involved in policy disputes involving legal interpretation ofmost major federal regulatory statutes.


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Biographies

Paul Debolt, Partner at Venable LLP, assists companies andindividuals on all issues that arise from doing business with thefederal government, including civil fraud. He is experienced inthe competitive source selection process, defending orprosecuting bid protests, issuing advice concerning compliancewith government regulations and laws during the performance ofa contract, and helping to resolve disputes and claims duringcontract performance or as a result of contract termination. Mr.Debolt also has significant experience with due diligence inconnection with the merger and acquisition of governmentcontractors, as well as post-transaction matters such asnovations. He counsels clients on the Service Contract Act, theCivil False Claims Act, joint ventures and teaming agreements,prime-subcontractor disputes and internal investigations.

Mr. Debolt has extensive government contracts law experienceand applies a team approach which ensures that clients receivethe benefit of firm-wide strength in all related areas.


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Biographies

John Farenish, Partner at Venable LLP, focuses on federal,state and local procurement law. He counsels and representsclients on the applicability and interpretation of governmentcontract-related case law, federal procurement statutes, theFederal Acquisition Regulation (FAR), and the Cost AccountingStandards.

Mr. Farenish has more than 30 years of experience in variousregulatory, compliance and prosecutorial capacities with thefederal government, beginning with the Army’s JudgeAdvocate General Corps and including seven years with theDepartment of the Navy. Prior to joining Venable, he spent 13years serving with the Defense Contract Audit Agency (DCAA),starting as deputy general counsel before becoming generalcounsel in 2003. He also spent several years with the DoD’sInspector General’s office handling criminal matters related tofederal acquisition policy.

Mr. Farenish has written and lectured extensively on aspectsof government contracting work, including ethics, compliance,criminal investigations, and the conditions for contractorsuspension and debarment.


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BiographiesDonald J. Shoff is the Chief Financial Officer and Senior Vice President ofFinance for INDUS Corporation, an information technology services companyoperating mainly in the Federal Government marketplace. For the last tenyears at INDUS Mr. Shoff has lead the overall responsibility for directing thefinance and administration activities, including bidding strategies, mergers andacquisitions, and working capital financing; those M&A activities includedleading the Company team in two significant acquisitions in 2005. Hisresponsibilities at INDUS also include significant involvement in all areas ofGovernment contract compliance and interface with Government audit/reviewfunctions.

Prior to INDUS he was the CFO and Vice President Finance of a publiccompany, zeroplus.com, Inc., formerly e-Net, Inc., since 1997 that he helpedco-found in 1995. During his tenure with the company, he has assisted incapital raising rounds including pre-IPO venture and angel funding, the InitialPublic Offering and post-IPO private placement rounds with both financial andstrategic partners. In addition to the capital fund raising, he was heavilyinvolved with the compliance and filing requirements, as well as interfacing withinvestment bankers, independent auditors and outside counsel.

From 1993 to 1996 he was a self-employed consultant as a part-timecontroller/CFO for small and medium sized professional and technical servicesfirms. From 1992 to 1993, Mr. Shoff was Vice President of Finance andAdministration for Comsis Corporation, a Washington, DC-based privatecompany doing business with the Federal and various state governments.From 1987 to 1992 Mr. Shoff consulted independently and as a Senior Managerat Grant Thornton, a major accounting firm, with public and privately heldcompanies doing business with the Federal government on issues such asindirect rates, cost recovery and profitability, and bid strategies. From 1982 to1986, Mr. Shoff was the Corporate Cost Accounting Manager and a GroupController for Science Applications International Corporation, a large hightechnology products and professional services public corporation, where hewas responsible for the corporate cost accounting functions and controller of ahigh technology services operation group. From 1977 to 1981, Mr. Shoff was astaff accountant and senior accountant on the staff of local Washington, D.C.public accounting firms, where he conducted compilation, review, and taxengagements for privately and publicly held corporations.


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Biographies

© 2012 Venable LLP

Jim Winner is Vice President & General Counsel and Vice President,Contracts & Procurement for the Information Systems Division of ITTExelis, headquartered in Herndon, Virginia. Jim’s previous ITT positionsincluded Associate General Counsel and Senior Counsel for ITT MissionSystems, headquartered in Colorado Springs, Colorado.

Prior to joining ITT, Jim served as Corporate Counsel for Cummins Inc.,in Indianapolis, Indiana. Jim joined Cummins after practicing law with thefirm Barnes & Thornburg LLP, specializing in contracts, procurement, andlabor and employment law. Jim’s work for Barnes & Thornburg includedan in-house assignment with Rolls-Royce Corporation, also inIndianapolis, Indiana, supporting Rolls-Royce’s commercial and militaryaircraft engine programs.

Prior to joining the private sector, Jim served as an active duty officer andjudge advocate attorney in the United States Air Force. His militaryassignments included: Deputy Staff Judge Advocate, Holloman Air ForceBase, New Mexico; Appellate Defense Counsel, Bolling Air Force Base,Washington, D.C.; Area Defense Counsel, Keesler Air Force Base,Mississippi; Assistant Staff Judge Advocate, Keesler Air Force Base,Mississippi; and Systems Acquisition Officer, Military SatelliteCommunications (MILSATCOM) Joint Program Office, Space and MissileSystems Center (SMC), Los Angeles Air Force Base, California.

Jim received his Bachelor of Science degree as a distinguished graduateof the United States Air Force Academy in Colorado Springs, Colorado.He received his Juris Doctorate degree, magna cum laude, from LoyolaLaw School in Los Angeles, California. Jim is licensed to practice law inCalifornia, Colorado, Virginia (Corporate Counsel) and Washington, D.C.


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Agenda

• Current Business Environment

• DCAA & DCMA Mission

• DCAA Initiatives and Business System Rules

Personal Conflicts of Interest Regulations

Contractor Response

• Audits

Managing an Audit

DCAA Access to Internal Audit Reports

• Common DCMA Criticisms

• DCAA Subpoena Power

• Sequestration

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• Contractors need to take preemptive risk management steps

to ensure compliance with Business System Rules

• Factors to Consider:

Heightened scrutiny and audit oversight by DCAA

Strict compliance and disclosure requirements

Expansion of audit inquiries

False Claims Act

Lack of communication between contractor and CO priorto payment withholds

Changing Business Environment

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DCAA Mission

The DCAA, while serving the public interest as its

primary customer, shall perform all necessary contract

audits for the Department of Defense and provide

accounting and financial advisory services regarding

contracts and subcontracts to all DoD components

responsible for procurement and contract

administration. These services shall be provided in

connection with negotiation, administration, and

settlement of contracts and subcontracts to ensure

taxpayer dollars are spent on fair and reasonable

contract prices. DCAA shall provide contract audit

services to other Federal agencies, as appropriate.

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DCMA Mission

The mission of DCMA is to “perform Contract AdministrationServices (CAS) for the Department of Defense, other authorizedFederal Agencies, foreign governments, internationalorganizations, and others as authorized.”

DCMA primarily works during two acquisition stages:

Pre Contract Award“DCMA provides advice and services to help constructeffective solicitations, identify potential risks, select themost capable contractors, and write contracts that meetthe needs of our customers in DoD, Federal and alliedgovernment agencies.”

Post Contract Award“DCMA monitors contractors' performance andmanagement systems to ensure that cost, productperformance, and delivery schedules are in compliancewith the terms and conditions of the contracts.”

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Interrelationship Between DCAAand DCMA

• DCAA plays an advisory role.

• DCMA, through its contracting officers and administrative

contracting officers, officially acts on behalf of the DoD.

DCMA often uses DCAA Audits when issuing pricing andcost allowance decisions.

o However, DCAA and DCMA often conflict with eachother when providing guidance to contractors.

o DCAA has also claimed that its findings have beenundermined by DCMA.

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DCAA Initiatives

• DPAP Memorandum (1/4/2011), “Better BuyingPower: Guidance for Obtaining GreaterEfficiency and Productivity in Defense Spending;‘Align DCMA and DCAA Processes to EnsureWork is Complementary’”– Increased Thresholds for Price Proposal Audits

– Forward Pricing Rate Agreements/Forward PricingRate Recommendations

– Financial Capability Reviews

– Purchasing System Reviews

– Contractor Business Systems Rule

– Ethics Compliance Reviews

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DCAA InitiativesRules of Engagement

• Issued guidance on establishing open andeffective communications with all stakeholders

• Rules cover communications during each phaseof the audit– Establishing the engagement– Entrance conference– During the audit– Exit conference– Post report issuance– Negotiations

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DCAA Initiatives Expectations fromContractor

• Effective contractor proposal walk-throughs

• Adequate contractor submissions and assertions

• Adequate supporting data in a timely manner andtimely access to key contractor personnelresponsible for contractor support

• Real-time DCAA access to contractor systems

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DCAA Initiatives Forward PricingProposals

• Adequate Contractor Proposals – Facilitate Effective Audit

– Proposed amounts supported by detailed basis ofestimate and supporting documentation

– Supporting justification/explanation provided forsignificant variances between prior buy actual cost dataand proposed amounts

– Consolidated Bill of Material– Detailed support for additive factors applied to various

cost elements

• Indirect Rates supported by contractor budgetary or trend

data

• Adequate Support for Subcontractor Proposals

– Adequate prime contractor cost or price analysis– Adequate subcontract proposal

• Proposal reflects anticipated accounting changes

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DCAA Initiatives Commercial Items

• Prime contractor is required to make a commercialitem determination (CID) based on adequatesupporting documentation and perform the appropriatecost or price analysis to establish a fair and reasonableprice in accordance with DFARS 244.402 and FAR15.404-3.

• Prime auditor is responsible for reviewing theadequacy of the prime/higher-tier contractor’s CID andassociated cost/price analysis as a basis for opiningon the adequacy of the CID and the reasonableness ofthe proposed subcontract costs included in the primecontractor’s proposal.

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DCAA Initiatives Commercial Items

• An adequate CID clearly identifies and supportshow the item meets the commercial itemdefinition in FAR 2.101. Generally, support for aCID would include market analysis andsubcontract sales history.

• Based on materiality and risk, the audit willinclude verifying subcontractor supporting data(sales and/or cost based) to the subcontractor’sbooks and records.

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DCAA Initiatives Long TermAgreements (LTAs)

• LTAs are an acceptable pricing method since FAR allowsprime contractors to reach price agreement with asubcontractor in advance of agreement with Government

• Auditors will evaluate the prime’s analysis of cost/pricingdata at the time the LTA was established and consider theprocedures performed by the prime contractor todemonstrate that the LTA price continues to be fair andreasonable

• Existence of an LTA prior to a prime contract award does notrelieve the prime contractor from obtaining certified cost or/pricing data prior to subcontract award when required byFAR 15.404-3(c)

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DCAA Initiatives Business Systems

• The interim Business System Rule was issued on May18, 2011

• Defines contractor business systems as the contractor’s– Accounting System (252.242-7006)– Estimating System (252.215-7002)– Material Management and Accounting System

(MMAS) (252.242-7004)– Purchasing System (252.244-7001)– Property Management (252.245-7003)– Earned Value Management System (EVMS)

(252.234-7002)• Includes a contract clause that requires the contracting

officer to apply a percentage of withhold (5%) when acontractor’s business system contains a significantdeficiency

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DFARS Rules: Business Systems –Definition & Administration

Interim rule published on May 18, 2011 (76 FR 28856)Final rule published on February 24, 2012 (77 Fed. Reg. 37)

Key Points:• Significant Deficiency: “a shortcoming in the system that

materially affects the ability of officials of the DoD to relyupon information produced by the system that is needed formanagement purposes.”• What does “materially” entail?

• Payment Withholding Decisions: CO finds one or moresignificant deficiencies in a contractor’s business systems.• CO may withhold up to 5 % for single business systems

deficiencies, and up to 10% for multiple businesssystems deficiencies.

• Applies to progress payments, performance-basedpayments, and interim payments per each coveredcontract.

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DFARS Rules: Business Systems –Definition & Administration

Corrective Action Plans: allows a contractor to implement aplan to address business system deficiencies. If corrective, COwill reduce or release payment withholds.

• If contractor submits an “acceptable” plan within 45 daysof the withholding notice, and CO finds the plan iseffectively implemented to address significantdeficiencies, the CO shall reduce withholding to 2percent. If contractor thereafter fails to act in accordancewith plan, CO shall increase withholding amount.

Correction of Business System Deficiencies• If CO determines contractor successfully corrected

deficiencies, CO will discontinue withholding and notifycontractor as such in writing.

• If CO does not act upon contractor’s successful plan within90 days, CO shall reduce withholding by at least 50 percent.

• If contractor thereafter fails to address deficiencies, CO mayincrease or reinstate withholding.

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The Roles of DCAA & DCMA

Section 893 of the Ike Skelton NDAA for FY 2011 provides thatthe program created to improve contractor business systems will“identify officials of the Department of Defense who areresponsible for the approval or disapproval of contractorbusiness systems.”

Responsibilities Identified in the Interim RuleDCAA

• Accounting; Estimating; Material Management &Accounting System (MMAS)

DCMA• Purchasing; Property Management; Earned Value

Management System (EVMS)

• DCAA & DCMA launched Cost Recovery Initiative to addressthe buildup of audits awaiting resolution.

• Focus of resources on high risk proposals:• Cost-Type Proposals ˃ $100 million; Fixed-Price

Proposals ˃ $10 million

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DCAA Initiatives Business Systems

• DCAA will report on compliance with the criteria inDFARS 252.242-7005

• DCAA Reports will identify significant deficiencies –defined by the interim Business System Rule as– Shortcomings in the system that materially affects

the ability of officials of the DoD to rely uponinformation produced by the system that is neededfor management purposes

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DCAA Initiatives Ethics Compliance

FAR Subpart 3.10 – Contractor Code of Business Ethics andConduct

FAR Case 2006-007, effective December 24, 2007• Added FAR requirements regarding contractor code of business

ethics and display of hotline posters (similar to existing DFARSrequirements)

DFARS Case 2008-D004, effective August 12, 2008• Deleted redundant coverage from DFARS

FAR Case 2007-006, effective December 12, 2008• Added requirement for disclosure of violations of criminal law or

the civil False Claims Act and consequences for failure to disclose.

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DCAA Initiatives Contractor Ethics

FAR 52.203-13

– Written Code of Ethics and Conduct

– Training

– Periodic Reviews

– Internal Reporting Mechanism

– Disciplinary Actions

– Full Cooperation for audits, investigations, orcorrective actions

– Disclosure of Improper Conduct to OIG

• Provides for possible suspension and/ordebarment for knowing failure to timelydisclose violations (FAR 9.406-2)

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Overview Personal Conflict of Interest

FAR 52.203-16 requires Contractors to:

– Screen for and prevent PCIs for covered employees

– Obtain and maintain “a disclosure of interests that mightbe affected by the task”

– Require each employee to update the disclosurestatement with changes

– Prohibit use of “non-public information accessed throughperformance of a Government contract for personalgain”; Obtain signed non-disclosure agreement

– Report violations to contracting officer

– Train employees to identify and avoid PCIs or the“appearance” of PCIs

– Maintain effective oversight to verify compliance

FAR 52.203-16(d): Subcontract Flowdown

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Personal Conflicts of Interest

FAR 3.1103(6); 52.203-16

– Report to Contracting Officer any PCI violation(written description of violation)

– Contracting Officer shall:

• Review Actions taken

• If KO is not satisfied, consult with “agencylevel counsel”

• DCAA review of files?

– Then what happens; refer tosuspension/debarring official?

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DCAA Initiatives

What This Means to you

– Increased Requests for Data

– Increased Access to Electronic Data

– Request for Documents Not in the OrdinaryCourse of Business

• Board of Director Meeting Minutes

• Internal Audit Reports

– Access to Records Issues

– Development of New Record Systems

– Development of Internal Monitoring Systems

– Alternative to Internal Audit Mechanism

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Response to New Audit Environment

Contractors need to take preemptive steps inresponse to DCAA’s increased oversight andcompliance requirements:

• Increase effectiveness of internal complianceprocedures, allocated resources, andcommunications regarding potential or ongoingaudits

• Increase communications with DCAA officials• Keep abreast of current regulatory regime to

ensure effective compliance

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Audits

How to Prepare for a DCAA/DCMA Audit

– Review prior DCAA Audit Reports and IdentifyIssues

– Review DCMA Reviews and Identify Issues

– Review Policies and Procedures

– Test Internal Control Structure Relating to Area tobe Audited

– Ensure Documentation (Data) is Current andAvailable

– Ensure Employees are Trained

– Perform Sampling of Area to be Audited

– Select a Liaison(s) to Work with the Auditors

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Audits

– Develop a Professional Rapport with the Auditors

– Take Notes on Auditor’s Request for Documents/Request thatthe Auditor put their Request in Writing

– Listen to the Auditor’s Questions/Request that Questions Be Putin Writing

– Provide Documents that Are Requested in a Timely Manner andin the Form Requested

– Do Not Establish too Many Levels of Review for Release ofDocuments

– Ensure that the Company Liaison to the Auditors Has theKnowledge and Authority to Release Documents

– Avoid Deemed Denial of Access to Records

– Do Not be Afraid to Ask Questions and Be Prepared to AnswerQuestions

– Document Disputes

– Take a Deep Breath – You Will Survive

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Effective Management of an Audit

In the beginning stages of an audit, contractors mustinternally communicate:• Types of audits and risk assessment levels• How and why an audit occurs; the length and

scope of an audit; resources needed for an audit

In the interim, it is important to understandcontractor data and relevant facts, and identifyomissions and mistakes.

At the completion of an audit, contractors shouldanalyze and respond to the results within anauditor’s draft report to account for anydiscrepancies.

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DCAA’S Access to Internal AuditReports

• Government Accountability Office Report No.GAO-12-88

• Report calls for greater access and use for DCAA toInternal Audit Reports

• DCAA will make more frequent requests

• SecDef to direct DCAA Director to designate POC foreach Company to coordinate request

• Set up a tracking system for number of requests anddisposition

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DCAA’S Access to Internal AuditReports

• Number of requests for access to internal audit

reports will increase

• Company should have their policies and

procedures reviewed for granting access to

DCAA to Internal Audit Reports

• DCAA may use Director’s Subpoena Authority to

enforce access denials

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DCMA Review of Terms and Conditions

• FAR 44.305-1 states:“The cognizant Administrative Contracting Officer isresponsible for granting, withholding, or withdrawingapproval of a contractor’s purchasing system. TheACO shall—

(a) Approve a purchasing system only afterdetermining that the contractor’s purchasingpolicies and practices are efficient and provideadequate protection of the Government’s interests;and(b) Promptly notify the contractor in writing of thegranting, withholding, or withdrawal of approval.”

• In accordance with FAR 44.305-1, DCMA will review acontractor’s terms and conditions and will providerecommendations and comments by memorandum to ensureprotection of the Government’s legal interests.

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Common DCMA Criticisms

In reviewing a contractor’s terms and conditions, DCMA

has commented on:

1. Missing Definitions of Critical Terms

2. Non-Appearance of Mandatory and Non-Mandatory Provisions and Flowdown Provisions

3. Rights of Contractors Versus Subcontractors

4. Express Inclusion of Statements in a Contractor’sTerms and Conditions to Protect the Government’sLegal Interests

5. Require Prime Contractor to Communicate Directlywith Subcontractor

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Practice Tips

In responding to a DCMA memorandum reviewing a

contractor’s terms and conditions, contractors should note:

• DCMA will comment on requirements and

recommendations. In many cases DCMA does not cite to

any regulations or acquisition law to support its

recommendations.

• Nonetheless, some recommendations, non-mandatory

flowdown provisions for example, may be necessary for a

contractor to comply with its prime contractor obligations.

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DCAA Subpoena Power Overview

• 10 U.S.C. 2313(b)

– What does it really say?

– Broad authority, but not as broad as youthink…

• Newport News Cases

– NN I

– NN II

– What was the difference?

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10 U.S.C. § 2313 – Examination of records of contractor

(a) Agency authority.

(1) The head of an agency, acting through an authorizedrepresentative, is authorized to inspect the plant and audit therecords of--

(A) a contractor performing a cost-reimbursement, incentive,time-and-materials, labor-hour, or price-redeterminable contract,or any combination of such contracts, made by that agency underthis chapter [10 USCS § § 2301 et seq.]; and

(B) a subcontractor performing any cost-reimbursement,incentive, time-and-materials, labor-hour, or price-redeterminablesubcontract or any combination of such subcontracts under acontract referred to in subparagraph (A).

(2) The head of an agency, acting through an authorizedrepresentative, is authorized, for the purpose of evaluating theaccuracy, completeness, and currency of certified cost or pricingdata required to be submitted pursuant to section 2306a of thistitle with respect to a contract or subcontract, to examine allrecords of the contractor or subcontractor related to--

(A) the proposal for the contract or subcontract;

(B) the discussions conducted on the proposal;

(C) pricing of the contract or subcontract; or

(D) performance of the contract or subcontract.

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DCAA Subpoena Authority Overview

SecDef, acting through an authorized representative,can, for the purpose of evaluating the accuracy,completeness, and currency of certified cost orpricing data required to be submitted under 10 U.S.C. §2306a, with respect to a contract or subcontract,examine all records of the contractor or subcontractorrelated to

– The proposal for the contract or subcontract;

– The discussions conducted on the proposal;

– Pricing of the contract or subcontract; or

– Performance of the contract or subcontract

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DCAA Subpoena Authority

(b) DCAA subpoena authority.

(1) The Director of the Defense Contract AuditAgency (or any successor agency) may require bysubpoena the production of any records of acontractor that the Secretary of Defense isauthorized to audit or examine under subsection(a).

(2) Any such subpoena, in the case of contumacy orrefusal to obey, shall be enforceable by order of anappropriate United States district court.

(3) The authority provided by paragraph (1) may notbe redelegated.

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• Look at 2313(b) first – that’s the directstatement of the Director’s authority– May require by subpoena

– Records of a contractor

– That the Secretary of Defense is authorized toaudit or examine under subsection (a)

– Refusal to obey a proper subpoena can be broughtbefore a US District Court for enforcement

– This authority belongs only to the Director, andcannot be redelegated

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What does subsection (a) say again?

– SecDef, acting through an authorizedrepresentative, can inspect the plant and audit therecords of

• A contractor performing a cost-reimbursement,incentive, time-and-materials, labor-hour, orprice redeterminable contract (or anycombination thereof); and

• A subcontractor performing the same type(s)of contracts

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DCAA Subpoena Authority Overview

• Bottom Line, the Director, and only the Director, canissue a subpoena –

– To a contractor or subcontractor only;

– If the contractor or subcontractor is performing acost-reimbursement, incentive, time-and-materials,labor-hour, or price redeterminable contract (or anycombination thereof); OR

– To evaluate the accuracy, completeness, orcurrency of certified cost or pricing data of acontract or subcontract related to

• Proposal

• Discussions

• Pricing

• Performance

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DCAA Subpoena Power Newport

News Cases

Newport News I

DCAA subpoena for internal audits of NNS

– Government argued:

• NNS did 98% of its business w/ the Gov’t, thereforewe’re entitled to the audits

• How can we check to see if the internal audit dep’t isdoing their job if we can’t see their audit?

– Holding: DCAA statutory subpoena power extends tocost information related to government contracts, butDCAA does not have unlimited power to demand accessto all internal corporate materials of companiesperforming cost-type contracts for the Government

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DCAA Subpoena Power Newport

News Cases

• Newport News II

– DCAA subpoena for financial info from NNS, to includetax returns, financial statements, and supportingschedules

– Government convinced the Court that access wouldallow DCAA to verify the accuracy of cost informationand corroborate NNS’ computation and allocation ofdirect and indirect costs to particular Gov’t contracts.

– Holding: DCAA statutory subpoena power extends toobjective factual materials useful in verifying the actualcosts, including G&A costs, charged by companiesperforming cost-type work contracts for the Government

– The key? “Objective” factual information vs. “Subjective”opinions of internal auditors in their reports

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THE SEQUESTRATION PROCESS

Audits, Investigations and Sequestration! Oh My!March 13, 2012 Tysons Corner, VA

Venable LLP

John F. CooneyVenable [email protected]

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THE SEQUESTRATION PROCESS

EXECUTIVE SUMMARY

1. Defense contractors are hostages in a showdown between

the President and Congress over fundamental decisions on

taxing and spending

2. The President has two leverage points in the struggle:

• The Bush tax cuts expire in early January 2013

• Many defense programs and contractors are subjectto major cuts under the sequestration process

The President’s January 5, 2012 defense spending

reduction policy is an integral part of this process – his

opening position in the negotiations

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DEFINITIONS OF SEQUESTRATION

• Webster’s Definition: To set apart, segregate, surrender forsafekeeping

• Legal Definition – An Impoundment authorized by law

Functional Definitions

• Sequestration = automatic, indiscriminate, across-the-boardbudget cuts to force reductions in spending to defined levelsestablished by statute

• Sequestration = a gun Congress holds to its own head toforce program advocates to propose and to agree tocompensating cuts elsewhere, for fear of having their favoriteprograms cut

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BASIC PRINCIPLES

1. If sequestration occurs, the automatic, indiscriminatespending cuts will be divided roughly equally between:‒ eligible defense programs‒ eligible non-defense programs

2. Many domestic entitlement programs are exempt from cuts:‒ Social Security‒ federal retirement programs‒ Medicaid‒ cuts in Medicare limited to 2%

3. The major difference between this process and the 1985-86Sequestration is that many more defense programs aresubject to cuts.This gives proponents of defense spending incentives tosupport tax increases and cuts in domestic discretionaryspending. It also gives proponents of domestic spendingincentives to raise taxes and cut defense spending.

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PROCESS FOR ADMINISTERING SEQUESTRATION

Step 1: OMB starts with the deficit reduction amountestablished by the statute $1.2 trillion

Step 2: OMB subtracts 18% of that amount for interest onthe debt

Step 3: OMB divides the remainder (an estimated $492billion) by 9, to allocate the spending cuts to each of the 9covered years

Step 4: OMB divides that amount by 2, to establish theamount to be cut separately from defense and non-defenseprograms

Step 5: OMB calculates the uniform amount each eligibleprogram in the defense and non-defense categories must becut

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CBO’s ESTIMATE OF EFFECTS OF SEQUESTRATION

1. Eligible defense programs will be cut by 10% in

Fiscal Year 2013

2. Eligible non-defense or “discretionary” programs

will be cut by 8.5% in Fiscal Year 2013

3. Medicare will be cut by 2%

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THE CRITICAL CONSIDERATION - TIMING

The sequestration will not occur until January 2, 2013 –the same time as the expiration of the Bush tax cuts.

This linkage, and the adverse effects of theindiscriminate sequestration, ensure that intense policyarguments will occur throughout 2012:

-- During the election campaign

-- Lame duck session

-- After the new Congress convenes

FASTEN YOUR SEATBELTS

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ADMINISTERING THE SEQUESTRATION --WHAT WILL OMB AND THE AGENCIES DO?

OMB ACTIONS

1. Determine the percentage cut for defense and civilianprograms.

2. Determine how to apply that cut to each separate line itemin appropriations bills, using scorekeeping principles firstdeveloped in 1985-86. Discuss with agencies.

3. Closer to the date of sequestration, OMB will implementthe spending reductions by formally impounding the fundsthat are sequestered. OMB will issue an “apportionment”to each agency.An apportionment is a legally binding order, enforceableby criminal penalties, that forbids an agency fromspending more appropriated funds than OMB allows. Itsnormal function is to smooth out spending through fourquarters.

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ADMINISTERING THE SEQUESTRATION --WHAT WILL OMB AND THE AGENCIES DO?

OMB ACTIONS (continued)

4. The President has substantial discretion in this process:-- Timing. Date on which apportionments are issued. Logical

time -- September 2012, prior to start of FY 2013. Smooth outspending to avoid first quarter rush?

-- Publicity. Pressure Congress prior to elections.-- Policy apportionments. The President may instruct OMB to

use its authority to promote his priorities. The apportionmentmay direct an agency to spend no more than $x or x% ofappropriated funds on Project 1, and to spend the remainderon Project 2.

Policy apportionments may support White House defense policypriorities announced January 6.

5. Reprograming. To reduce the adverse effects of indiscriminatecuts and respond to emergencies, OMB and agencies willaggressively utilize existing reprogramming authority to shift fundsaround.

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WHAT AGENCIES DO

1. Determine how to implement uniform percentage reductionby imposing uniform percentage spending cuts within eachline item in its appropriation bill.

2. Discuss preliminary policy choices with OMB and WhiteHouse for consistency with Presidential policy. This mayinclude January 6 Defense spending priorities.

3. Consider reprogramming funds to reduce adverse effectsof sequester, if legal authority exists.

4. Agencies will have great discretion in administratingsequestration. Examples include:-- Allocation among programs in a line item.-- Allocation between personnel reductions and contract

expenditures within a program.-- Allocation among contracts within a program.

5. This process will take several months to implement.Contracting Officers will be told the impact on theircontracts relatively late in the process.

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POSSIBLE EFFECTS OF SEQUESTRATION ONCONTRACTS

1. The agencies will try to minimize recourse to terminationfor convenience. They will manage their contracts toreduce the amount that is deemed obligated.

2. Cost reimbursement contracts. The agency can controlthe “best efforts” that a contractor can exert -- i.e., we willpay only $y, use your best efforts within that cap.

3. Indefinite delivery/indefinite quantity contracts. Informcontractor that the agency will obligate only $y in the fiscalyear, to a level below original expectation. Agencies willbe reluctant to exercise their rights to extend for optionyears.

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POSSIBLE EFFECTS OF SEQUESTRATION ONCONTRACTS

4. Service contracts. Agencies will be reluctant to exercisetheir rights to extend for option years and may use theprospect of non-renewal to renegotiate down costs.

5. Do not enter into new contracts. This will be a commonagency practice in year one of a sequester. Procurementsthat can be put off will be put off.

6. Contracts funded with money obligated in prior FiscalYears are protected.

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STEPS YOU SHOULD TAKE

Be proactive.

Reach out to agency policy officials directly or throughtrade associations. Advocate the importance of theprograms your contracts support.

Stay in close touch with your Customers within theagency. Emphasize the importance of your contracts tothe program. Obtain information about the agency’splans for your contracts.

Your Customers may not know the fate of your contractuntil late in the process. Contracting officers will befurther behind the curve.

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© 2012 Venable LLP

Questions? Comments?

John F. Cooney, [email protected] 202.344.4812

Paul A. Debolt, [email protected] 202.344.8384

John M. Farenish, [email protected] 202.344.4462

Scott Hommer, [email protected] 703.760.1658

Donald J. Shoff, CFOINDUS [email protected] 703.852.9430

Jim WinnerV.P. & General CounselITT [email protected] 703.668.6490

www.Venable.com